In Defense of HFT: “They’re good for price discovery.”

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After all the negative press on HFT lately, at least one group of researchers, at the European Central Bank, has come out with a contrarian viewpoint.


Their views were published in a working paper entitled “High Frequecy Trading and Price Discovery,” and here is their paper’s abstract:

We examine empirically the role of high-frequency traders (HFTs) in price discovery and price efficiency. Based on our methodology, we find overall that HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days. This is done through their liquidity demanding orders. In contrast, HFTs’ liquidity supplying orders are adversely selected. The direction of buying and selling by HFTs predicts price changes over short horizons measured in seconds. The direction of HFTs’ trading is correlated with public information, such as macro news announcements, market-wide price movements, and limit order book imbalances.

Geoffrey T. Smith, writing on the WSJ’s Real Time Economics blog, points out that the view above is the researchers’ and not the ECB’s:

Before anyone gets too carried away, the view isn’t an official one: all the ECB’s working papers are presented as the opinions not of the bank, but of their authors — in this case Jonathan Brogaard, Terrence Hendershott and Ryan Riordan, three academics of transatlantic origin, all with a track record of defending HFT, and none of them permanently retained by the ECB. Moreover, a cynic would point out that the authors have drawn their data only from U.S. equity markets. One might be forgiven for thinking that the ECB would have given the paper a heavier edit if it had been euro-zone government bonds, rather than U.S. equities, that had melted down in a ‘”flash crash” at the height of the euro crisis.

As I wrote in my own review of Flash Boys ( the problem is not HFT, per se. There will always be very smart guys with very fast machines making money ahead of the really smart guys with really fast computers. From a purely academic perspective, there is a “technical” argument to be made that HFT does accelerate price discovery along with an overall liquidity surplus, as the ECB authors note (albeit with some big caveats thrown in):

Overall HFTs have a beneficial role in the price discovery process in terms of information being impounded into prices and smaller pricing errors. Traditionally this has been viewed positively as more informative stock prices can lead to better resource allocation in the economy. However, the information HFTs use is short-lived at less than 3-4 seconds. If this information would become public without HFTs, then the potential welfare gains may be small or negative if HFTs impose significant adverse selection on longer-term investors.

Our evidence on HFTs’ liquidity demand immediately following macroeconomic announcements may fall into this category. However, HFTs’ liquidity supply at this time is greater than HFT liquidity demand so overall HFTs are not imposing net adverse selection on others around macroeconomic news.

At the purely technical level, HFT firms probably do play some sort of efficiency-enhancing market function (though a lack of data means that the jury is still out on that question). From a capitalist perspective though, a market sector that generates returns with little or no risk at the expense of risk-taking (therefore capitalist) entities is, in the big picture, not a good thing. In other words, just because something is good for the stock market does not make it good for capitalism or society.


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